Entrepreneurs, Investors and Financial Engineers – Not All are “BusinessPeople”

The most interesting aspect of the debate last night was with the President referring to Gov Romney as an investor while Gov Romney referred to himself as a businessman. It’s a distinction with a huge difference.

It made me think back to a post I wrote almost exactly 4 years ago, prior to the last election. We need entrepreneurs. We need Investors. There is definitely a place in the market for “spreadsheet capitalists” Just as short sellers can help us identify poor companies or poor company habits, SpreadSheet Capitalists make us realize just where our system is wrong and needs to be changed, but we have to also recognize the parts of the system they will exploit and the HUGE problems they will cause to our economy if not proactively considered. With the multiple bubbles and collapses of the last 20 years my hope is that we will have learned some lessons. We can’t do the same things over and over and expect different results. LIke everyone else I want to see more people go back to work. In fact, I’m investing in companies as fast as I can to help add to the economy and create jobs. But we can’t let our desperation to create jobs blind us from the exact problems that put our economy in this position.

The Cause of Bubbles =Investment vs Financial Engineering

Oct 11th 2008 3:12PM

Let me get this straight.  In 2008, funds trying to squeeze out another basis point or two thought they were being conservative  buying insurance on heavily leveraged portfolios of sub prime loans and other debt. Once those loans started to default, it  created a cascading deleveraging event which lead to major financial institutions failing and the “smartest” minds on Wall Street being forced to dump everything to raise cash, which in turn lead to a crisis of confidence and deleveraging that created the worst week in the history of the stock markets. Did I get this right ?

In 1987, funds, trying to squeeze out another basis point or two thought they were being conservative, buying insurance on leveraged stock portfolios. Once the stock prices on those portfolios started to drop, their insurance programs pushed them to dump everything AND sell stock index futures to raise cash, which in turn lead to a crisis of confidence and deleveraging that created the worst single day melt down in the history of the stock markets.  Did I get this right ?

Think it wont happen again ? Of course it will.  Whatever money the Fed makes available to stimulate the economy will be used, as intended,  by entrepreneurs and businesspeople to create and grow businesses.

Unfortunately, it  will also be used by financial engineers to try to find a way to make HUGE profits from  highly leveraged,risk laden financial packaging. Why wouldnt they ?

If you can borrow  cheap money  , invest  in some asset that can be marked to an increasing market, borrow  against the gain and buy something else and do it as many times as possible,  wouldnt you ? Its exactly how homeowners In a bull market drove up real estate prices with a few making huge money.

If you could do the same thing, but instead of with houses, with stocks or asset backed securities, and instead of with thousands, do it with billions so you could profits in the 10s of millions or more, wouldnt you ?

Hell yes you would. You certaintly arent going to tell yourself that you could be creating the next big bubble that could rival 1929, or for future generations, would rival 2008, so dont do it. You would go for the money.

Which is the genesis of our problem in the US.  Its not wrong to run with bull markets and leverage to the hilt. That can be a very good thing. But we have to make the upside based on investments, rather than financial engineering. Which is exactly why we have to change our tax code. We want to encourage investment, not financial engineering.

The financial  markets  were originally defined as markets that created capital for businesses to start and grow.

Today, that is rarely the case. Sure companies do come to the markets for cash for growth and that should be encouraged.  But those examples are a tiny percentage of the market.  When a stock turns over its float multiple times in a day, those are not investors buying and selling the stock. Those are traders or financial engineers.

The ONLY WAY WE ARE GOING TO END THIS BOOM AND BUST CYCLE IS IF WE DIFFERENTIATE BETWEEN INVESTORS AND EVERYONE ELSE.

Investors should be rewarded for actually owning companies and gaining returns on their investments. Financial engineers should have to pay a premium for the risk they introduce to the entire financial system. It was not investors that brought on the last 2 crashes. It was the financial engineers.

The beautiful thing about this country is that we like to work hard, and we like to take chances. Unfortunately, over the last 15 years, the incentives have been to take chances as a financial engineer rather than as an entrepreneur. We give far more money to people who play games with financial instruments than we give to people who come up with ideas for the next big thing.  That needs to change if we want to remain a leader in this world.

Here is what I would do to change things

I would change to zero the taxes on any gains from the sale of stock or bonds purchased during an IPO and held for 5 or more  years. All dividends/interest paid by that stock/bond would be tax free. If you sell it prior to the 5 years, you are taxed at your personal regular income tax rate.

In addition, I would not allow the stock to be borrowed against in any way. If it was, it would be considered an effective sale. Which means you couldnt borrow on it tax free until you have held it 5 years.  Bottom line, if you hold the stock/bond , like a real investor would, you are rewarded for it.

For purchases  post IPO, in the open market,  the same rules apply, except I would tax at personal income rates the dividends/interest  for the first 5 years of ownership.

For all other transactions, whether they are options, derivatives, stocks, bonds, whatever, all gains and losses would be taxed at personal income rates.

If you are a great financial engineer and make tons of money at what you are doing, more power to you.If you are good at what you do, you pay more to Uncle Sam, but you still make a boatload of money.

I would keep taxes on private transactions, just where they are. Private transactions are less liquid and harder to value, which in turn makes them harder to borrow against. Which reduces leverage in the system and encourages investment. Its hard to financial engineer a private company. I would tax gains and losses in private companies at capital gains levels, but I would extend to  3 years the marker to not be considered a short term investment. I would keep the active vs passive rules.

Next there is the issue of leveraging. No one ever complains when cheap cost of funds creates leverage and drives a market up.  And no one ever will. So we have to set strict leverage limits. We set margin/leverage limits on day traders as the tech bubble burst. The only difference between the day traders of the tech bubble and the Investment Banks and AIGs of the world that cratered in this bubble is that the big guys started with more chips at the table. And they picked their own credit lines and there was no pit boss to watch over them. I would limit to 2x the leverage available on any asset that is insured by the government or is offered by any organization that is elgible for government insurance  or tax incentives of any kind.

Of course, I would still levy a fee of anywhere from 1c to 10c on every transaction of stocks or bonds which would go into a general fund, that I will call the “Oh Shit We Missed It Fund”. It will be there to fund the inevitable situation where someone figures out how to work around whatever regulations and tax code that is created.

As an entrepreneur, I can tell you that this would not change how I ever started or invested in any business. As someone who trades stocks, It would impact my investment decisions. I would only trade out of necessity. I would be willing to take lower yields on my investments, making it cheaper for companies to raise funding.

I also recognize that it would mean that the chances of the Dow ever hitting 14k in 2008 dollars is about as likely as my catching my elbow on the rim playing basketball. I dont think thats a bad thing.

46 thoughts on “Entrepreneurs, Investors and Financial Engineers – Not All are “BusinessPeople”

  1. Pingback: Mark Cuban-The "Mavericks" Self Made Billionaire | Scopegater

  2. Hey Mark,
    Your points about financial engineers are mostly correct. I would just urge caution about dramatic increases to their tax rates. These people provide the liquidity in the markets that lowers the cost of capital for the rest of us. They can at times be collectively stupid, but we cannot legislate away fear and greed.
    Encouraging entrepreneurs and serious investors is a much better idea.
    Introducing TTA Marine LLC:
    Working to prevent the next BP/Macondo, we diagnose critical systems for commercial marine and offshore operators. My partner is an electrical engineer and veteran of several Silicon Valley start-ups. I am a business generalist with management, manufacturing and selling experience. Our prototypes have been tested. Premarketing was successful. We use proprietary technology, and custom software. We can tell operators about the state of health of emergency and back-up batteries. A typical offshore installation has hundreds. We can also diagnose the health of critical working liquids such as engine oil, hydraulic fluid and fuels. We make hidden problems visible thereby avoiding catastrophic failures. We need 3 months work to be ready for market.
    Bob Mullen
    bob.mullen3@gmail.com

    Comment by Bob Mullen -

  3. Pingback: Episode #127 – Generating Wealth and Re-Considering Retirement for Entrepreneurs

  4. Pingback: Entrepreneur Roundup: SEO, iPhone, Breast Cancer, DC & Risk » CEO Blog Nation Beta

  5. I own a distilled spirits plant in Greenville, TX….only legal distillery in East Texas. My plan is to produce RTD’s (ready to drink cocktails), vodka, and rum, to name a few. Currently, I have two RTD formulas and labels approved by the TTB and am sitting on go to land a distributor. Trademarks, URL, and permits are in place. I need an investor. Thanks!

    Comment by texashideoutdistillery -

  6. Pingback: The Best Damn Wall Street “Week in Review” Anywhere… « MarketSnacks

  7. Mark is the man!!

    Comment by wefixbadcreditdotorg -

  8. Mr. Cuban. I really liked the article. I do agree that we can’t do the same things we did before and expect different results. But, how would a future entrepreneur as myself find funding in times like this. I have a plan for a dialysis center that actually fits the President’s changes in medicare that would be very successful.

    I have taken time to research and provide all related information to possible investors. Right now, banks are structured in a way that they don’t lend to many new businesses, especially minority owned business. Looking for investors has been a big hassle as well. There are so many ways to look for investors, but actually getting them is next to impossible for me.

    Is there a way to actually bridge this gap and find investors for medical ventures where you can talk directly to them? Once you see our plan, it would peak the interests of most investors.

    Thanks,

    Shannon Glover
    shannonvglover1972@gmail.com

    Comment by shannonvglover -

  9. The stock market rallied around 10% on the next trading day after you wrote the 10/11/08 article. Just sayin’ ;-)

    Comment by implosion1 -

  10. Mark, I like your ideas on taxes very much. Why are we still putting so much emphasis on how money was made when taxing it? The govt needs about 20% of GDP to run it’s massive foreign and domestic adventures and that means we have to get about 20% each citizens. Massive rounding of numbers, but Simpson Bolles has it just about right.

    Once the tax code was changed to favor attaining wealth thru cap gains, that made it plain for me which way to go. It was a mistake by our lawmakers, but the rules were set and I followed them to maximize my results. It is a failure because the wealth has coagulated in the low tax areas of real estate, stocks, currencies and gold etc, and now the revenues to the govt are not meeting the commitments of entitlements and wars.

    When the government needs to urgently raise revenue and cut expenditures, it seems like the logical time to take away the special treatment for cap gains. Why lightly tax real estate and stock market gains while hitting income from paychecks at about double, 15% CG vs 28-33% W-2 earnings for even a minute longer when our whole system is as sick and endangered as Greece and Spain’s?

    I’ve operated under this system for over 20 years and it’s worked well for me because of the simple math that favors capital gains over W-2 paychecks, but I can say from experience that it is not fair. I’ve kept an extra 15% x 20+ years for what? And it is not a system that I want the next generation to operate under. It’s been 25 years since “Wall Street” and Oliver Stone is still trying to explain that Gordon Gekko wasn’t supposed to be admired, let alone idolized. Can our generation ever reflect for a few moments and realize having Wall St run our banking system, Govt Sachs, and the capital markets has yielded subpar to horrible results?

    Mark Stender

    Comment by Mark Stender -

  11. Hello Mark, everything happens for a reason and I had a dream this day would come. Here’s your second chance at luck. My name is Johnnie Walker and I have a startup called Movie Grub: A mobile app that allows Movie Goers to order food from a Movie Theater’s Theater Concessionaire ahead of time and have it ready for pickup upon arrival. “Get off that Stupid Line and get on Movie Grub” Check us out, we are looking for an angel investor thats a “Business Maverick” gust.com/c/movie_grub.
    We’re similar to these guys: http://bypasslane.com/pages/fans

    Comment by Johnnie Walker (@MovieGrubapp) -

  12. Dear Mr. Cuban,
    I ran across this blog while searching for an address to send you a copy of a book I have written, Stop the Insanity Target 2014. In the book I offer a plan to turn around our dysfunctional government in Washington and suggest twelve important first steps that should be taken once a functional government is in place. A key element in the plan is getting thirty or forty highly competent and Independent minded candidates to run for Congress in 2014. This small group could help save our country. I would like for you to be one of the group! You are a brilliant and successful businessman. I’d like for you to become a great statesman.
    BTW The book will be published on Amazon in mid November after the election since the foreword discusses the election results. However, I would be happy to send you a word file copy now if you can send me an e-mail address.
    ps I have attended a number of Mavericks games and they have won every game I attended.
    David Welch

    Comment by mytoppy -

  13. Do you think the financial industry would stand for a transaction tax? I doubt it.

    Comment by Ciprian Pătrulescu -

  14. All good points, and I agree.

    Comment by imarunner2012 -

  15. Very interesting blog post, and actually has been falling in line with alot of concerns I’ve had with modern tax codes for some time.

    I’m part of the 1%, and one thing I’ve been concerned about is how the current financial system disproportionately rewards speculative behavior on the part of players in the financial system.

    Carried interest, and the lack of distinction between speculation and investment creates a set of perverse incentives.

    Personally, I think 5 years is too long a time frame for a binary tax outcome.

    There should be rewards for those that purchase companies and turn them around, or who provide short to mid-term financing for start ups. Those time frames will often be shorter than 5 years, but certainly longer than the current non-existant requirements.

    Personally, I would like to see the following in play.

    1) Elimination of all carried interest deductions. The whole idea behind the capital gains rate is to incentivize investors in enterprises because they take on risk. Those who manage hedge funds take on no such risk. It’s ridiculous that someone that has NONE of their own skin in the game can recieve preferential taxation. Given that many hedge funds operate on the 20% of profits, but zero of the downside, they should in essence be viewed as consultants or hired expertise.

    2) Set a minimum hold time to take a capital gains rate for the sale of stock options. For those in upper management who take on large stock options, the ability to turn over significant portions of their stock at the capital gains rate incentivizes the juicing quarterly earnings in the short term in order to take advantage of that rate. Enforcing some sort of minimum hold time to get the best rate (like 2 years) would put a longer term window on management incentive, bringing their benefits more in line with shareholders.

    3) Some sort of scaled rate on capital gains based upon time held. Something like 15% if held less than 1 year, 8% if held less than 2 years, and 0% if held 3 years of longer. Given the uncertainties of stock investment, I think this would more than adequately account for the short term speculators. Also, it would make sense to have some sort of minimum amount earned before being subject to capital gains tax rates –maybe a one time lifetime exemption of $500k. This would incentivize individuals to invest, and not penalize household investors.

    As for the protests of Value investors, we should remember that Buffett made a great deal of his fortune BEFORE the advent of modern financial engineering. While the large amount of speculative monies in the market does allow for large price volatiliy, we Also have to consider that the value of securities in general are inflated when you incentivize speculation.

    I would argue that while you would decrease the amount of volatility, I would also argue that that volatilty creates artificially high price averages which reduce the actual number of value investment opportunities.

    For example, going back to Benjamin Graham’s classic smell test, if you use a 6 or 8 PE ratio as a criteria for investing, very, very few stocks would meet that smell test. With current PE’s running in the teens to 20′s regularly, it’s very hard to justify the actual value of Most companies in the public space except speculatively, on some sort of projected growth model, or on a technical momentum investing basis.

    On a side note, I do think there are other taxation issues that should be addressed. For example, the ease with which wealth can be transferred from asset to asset almost indefinitely through the 1029 exchange, as well as the current structure of trusts that allow families to crystalize asset values at current valuations and then defer any sort of tax implications for decades.

    And let’s not get into specific tax breaks like the mortgage home deduction (a sacred cow I know), which brings into play it’s own set of pricing and asset allocation distortions.

    Those of course are a topic for another day.

    Comment by George Lynn -

  16. Once again, thank-you for your willingness to “tell it like it is” Mark. I’m confident you know the workings of the stock market better than I, and I think all of your proposals would improve the outcomes and bring stability and sanity to the financial markets.

    I will say that I have a strong proclivity to be more of a free market guy, and though I think your solutions would provide needed controls, those controls could be achieved through free-market means if the government would STOP using tax policy to get middle class Americans to mindlessly send their fortunes to Wall Street through their company sponsored 401K retirement plans.

    I think people become lemmings thinking they are doing the right thing mindlessly pushing trillions of dollars to Wall Street because there is a tax advantage to doing so. The middle class provides the mutual fund money managers the cash they use to move the market. Mutual Funds pack the boards of directors of companies with “their guys”, and the interest of the individual investor is ignored. “We” don’t own stocks anymore we own mutual funds. Yet we middle classers still keep pushing trillions to them so they can continue to do what they are doing.

    I would DEFUND Wall Street by changing tax policy.

    Just think of how many more entrepreneurs we could have if people didn’t take all their extra money and throw it in their mutual funds/401K because the tax shelter alone guarantees a return at least as great as your tax rate?

    It sounds noble to let people shovel money into a 401K tax free, but its just feeding the beast.

    If your 401K wasn’t tax deferred, how many people would give more thought to making better investments with it? Like starting a small business? Or investing in a friends small business? But all that has to be done with AFTER tax dollars, so people don’t even think about it.

    How many people might buy a rental property for their “retirement” investment instead of shoveling money into a 401K but for the fact that they have to use AFTER tax dollars to do it? How much safer would that kind of investing be than throwing your money at wall street hoping they don’t crash the markets with it… again…

    Comment by wisconsincarry (@wisconsincarry) -

  17. Financial Engineers have convinced Bernake and others to implement QE3. QE1 and QE2 did not ignite the US economy. Financial engineers are now orchestrating another collapse. The Federal Reserve is now buying $40 billion per month of mortgage securities. The mortgage lenders are using this paper swapping of mortgages to invest in treasury notes tied to more derivative schemes. All of those market checks you propose in this blog are being circumvented by the financial engineers.
    It is the federal reserve that will own the homes in the USA when the homeowners’ lending institutions default due to derivative implosions.

    Comment by joesmith7789 -

  18. Mark we appreciate you investing in companies that will hire. Unfortunately many college graduates and displaced workers are not being hired even with an influx of capital investment to their industries. Human Resources of these companies have an agends to hire as many foreign visa holders that they can. It is not only outsourcing that is destroying the USA but insourcing.
    Check through all of your companies’ employees records and check the percentage of foreign visa workers employed.
    The cost savings of hiring a H1B web illustrator compared to a college graduate or experienced displaced experienced US citizen is 15- 40% over the H1B term.
    When the H1B’s visa expires the employer sends the H1B employee to Toronto and then after a 48 hour waiting period has the employee return to work with a TN visa even though the H1B is not a Canadian citizen who the TN visas are reserved for.
    Foreign visa workers earn less, spend less and contribute less than US citizens
    Eliminate these foreign work visas since only the cheaper not the better and brighter foreign workers are being insourced to the USA.
    There are several million documented foreign visa workers gainfully employed now in the USA and they are the main reason why the economy is faltering.

    Comment by joesmith7789 -

  19. Another brilliant piece, Mark. I hope one of these days we can persuade to keynote one of our acclaimed industry events focused repairing market structure.

    @nick sparagis, you bring up a very valid point. Most retirement plans force people to invest in conventional assets with limited growth. You should look into self-directed IRAs where you are given the flexibility to invest in almost anything you want: private growth companies, franchises, real estate. Hell, you can even use it to fund your own start-up.

    Comment by nowstreetjournal -

  20. Aloha Mark,

    Sounds like a great idea. And don’t take this the wrong way, I support this idea and I am a fan of yours.

    But how do you get this enacted into policy and law? It’s been 4 years since you wrote this and it doesn’t seem like anything has changed. You are a smart and resourceful guy, it might be time that you take some action on this.

    I believe you mentioned that ultra rich folks, like yourself, should pay higher taxes. (If I am making this up, I apologize. I thought I read that somewhere. I know this might sound sarcastic, but it’s not.)

    One idea is that you self-impose a “tax” on yourself and then use that money to hire a lobbyist to get this going. Plus with that self-imposed “tax” hire a marketing firm to support the lobbyist and garner the support it would need. You would probably need/get support from the people that would profit from this. Obviously the battle will be fought with those that will lose from this.

    The system is still malleable. Please be the leader that you are and make this real. Otherwise, you’re all talk and no action. I’ll help you in any way that I can. But you will have to take the lead on this. Or designate/hire a qualified person to do it.

    I hope you aren’t offended but I think you’re a pretty straight shooter and would appreciate straight talk. In other words, get off your ass and make this shit happen, you’re a billionaire for crying out loud.

    -Jeff Orig

    Comment by Jeff Orig (@origmedia) -

  21. My concern with the stock market is that you’re practically forced to put your 401-k there. We go as the stock market goes.

    Comment by Nick Sparagis (@Sparagi) -

  22. Pingback: Entrepreneurs, Investors and Financial Engineers – Not All are “BusinessPeople” | {clearly} not astute

  23. *AMEN!*

    Bob Aronin

    Comment by aronin -

  24. Hi Mark,

    I agree with you that there is something fundamentally wrong with the incentives in the system that is causing a bubble in Financial Engineering. It is even plausible that tweaking the tax code could help steer some capital from unproductive activity towards more productive, real economy activity. However, I think that something larger than tax incentives must be the root cause of this problem. My sense is that it is related to the monetary system and regulatory framework.

    I do not agree with you when you compare this to individual home owners using mortgages to invest in rising real estate markets. These two things are totally different because in the case of the home owner, individuals have to borrow money from lenders in order to obtain leverage. However,banks are a totally different entity than households. The key difference is that a bank does not need to borrow money from anyone in order to obtain leverage – bank have the power to simply create money of thin air and lend it to themselves to then speculate with. In fact, banks don’t even need print the money out of thin air in order to obtain leverage, they can obtain leverage by just entering into derivatives contracts. When banks trade derivatives with other banks they have to post collateral, but typically when banks sell derivatives to non-bank entities the bank never has to post any collateral (only the bank’s has to post collateral to the bank). This type of activity takes up an ever increasing share of global trade in monetary terms, as you have noted. This strange, phantom form of “money” that banks call “capital” is based on accounting entries and spreadsheet models that highly opaque and susceptible to manipulation. There is a principal in economics called Gresham’s law which states that “bad money drives out good.” Gresham’s law was formulated in a time when medieval monarchs were in the habit of debasing gold coin. In our time, we have fiat currency and the aristocracy of “Wall Street” is in the habit of debasing our fiat coin with their mysterious “capital” numbers that cooked up by the infamous “Financial Engineers.”

    These strange powers that banks have come from laws and regulations. Banks have been trading financial derivatives in significant amounts since the 1970s, and over the past 40 years this has evolved into a festering economic storm that nobody can completely see or comprehend. The global economy has been increasing devoting real economic capital towards activities related to financial alchemy schemes rooted in the the phantom money that banks pull out of thin of is a monster with a life of its own. Like Frankenstein’s monster, the global financial system (fuled by central banks and Financial Engineering) has taken on a life of its own and this monster does not have any sympathy for the plight of humanity. This “vampire squid, sucking on the face humanity” operations on a global scale. The US tax code is no match for the system, legal entities and people simply re domicile in a game of regulatory arbitrage. For banks, finding ways around the tax code for their customers is even a source of revenue. The regulators are never smart enough or fast enough to keep up with the system. The rocket fuel of central bank liquidity, combined with the infinite variety of possible financial derivatives, lets this particular industry propel so far ahead of its regulators that “regulatory capture” is simply taken for granted.

    I don’t know what the answers are and I don’t dare to offer a remedy. But I do think that if a Private Equity fund manager from Wall Street is elected as the next President of the United States then he will do for the world’s economy what George H.W. Bush did for world peace. I don’t understand how Americans, after having witnessed the greatest financial calamity caused by Wall Street in generations, can be seriously considering to elect a Private Equity guy off of Wall Street as their next President.

    Comment by aamirm -

  25. In response to Mark Cuban’s response to my comment above, I do believe we need to address the systemic risk issue in a thoughtful way. At a high level, I think we agree that systemic risk is a problem. We disagree, though, on what the root cause of systemic risk is and therefore how to address it. In my opinion, the underlying problem is not (active) trading, aggressive speculation in stocks/bonds, or even “financial engineering/innovation.” It is the fact that institutions *with balance sheets large enough to represent a systemic risk to the financial system* and executives/employees *with personal incentives that misaligned their interests with those of their companies’ shareholders* took on tremendous risk with both the explicit backstop of bankruptcy laws and the implicit government backstop.

    The aggregate volume of financial transactions (or speculation) is not what causes or increases systemic risk and a transaction tax is, by far, the boldest and most unconventional proposal in the post above. How would one differentiate between a qualifying transaction and any other type of contract where one asset is exchanged for another? However one defines “stock or bond”, the first order of business would be to construct alternative securities with similar risk/return characteristics that are exempt from the tax. Even if one hypothetically had a perfect definition, you are effectively discouraging liquidity in precisely the same instruments that allow businesses to be capitalized. Less liquidity means rational investors would apply lower stock/bond valuations (as there would be a greater illiquidity discount) and it would be more difficult to induce investors to capitalize businesses with these securities relative to other potential investment options (real estate, derivatives, private equity, etc.).

    If liquidity were removed from the market as a result of the introduction of a transaction tax, you might also see more short-term volatility and potential for irrational pricing, and larger bid/ask spreads. Looking at the behavior of less liquid stocks today relative to more liquid issues, you will often see this. Liquidity is a good thing and a tax which removes liquidity from the market is likely to have unanticipated consequences.

    I have an enormous amount of respect for Mark Cuban and hoped policy makers would come forward with innovative ways of addressing the systemic risk issue in a more robust and thoughtful way in the aftermath of the last crisis. Some of the post’s proposals make a lot of sense in this context including imposing leverage limits and capital reserve requirements. For other reasons, I also support treating many classes of investment income as ordinary income (I would probably go further on this point and not give any investment income preferential treatment).

    Taxes are not only a means of funding the government; they also establish a system of incentives. Creating a disincentive to trade is counterproductive; however, creating a disincentive to build a systemically risky organization could be very helpful at preventing another crisis. it is not yours and my transactions that should be taxed to create an insurance fund for institutions that represent a systemic risk; instead, organizations that represent a systemic risk, as identified by regulators, should be forced to pay a “risk tax” to fund this insurance pool. The formula should be a function of the size of the organization’s balance sheet, its leverage ratio, the types of assets and liabilities on its balance sheet, etc.

    The misalignment of large company executive/employee interests with shareholder interests is also a problem but I’m not sure of an effective way to address it from a public policy standpoint.

    Comment by Lenny Grover (@lennygrover) -

  26. You’re making a distinction in the wrong place. Elephant gun for the mouse?

    You have bacteria in your stomach. Some of it is necessary to digest food and some of it can kill you. Would it not be a huge mistake to declare war against all bacteria? This is what you’re doing. HFT and dark pools are the bad bacteria you want contained. Scalpers, day traders, and swing traders are the good bacteria. They HELP investors digest orders and have ZERO impact on a long term time frame. Their existence is only beneficial to the investor.

    Any future regulations should aim to:
    1) At the very least contain HFT. Put an extra tax on profitable trades shorter than 30 seconds-1 minute. A tax would crush the penny scrapers.
    2) Possibly eliminate dark pools?
    3) Limit leverage outside of the public market (agreed).
    $) Maintain a healthy environment (market and taxes) for both investors and short(er) time frame participants.

    Comment by Sdf Dsfds -

  27. Mr. Cuban, very interesting Ideas. As a man of your stature, I am truly grateful you are brave enough to share this insight. A fundamental problem with humans is what is excessive and what is not. If one can buy something for $1 and have the buyers to sell it for $50 or $10,000, no one really looks at the overall effect on the economy that either price may lead to. Selling that same item to someone of your wealth status likely would not have the same effect as selling that same item to someone making $90,000 a year. Hence, we see some people making large amounts of money and their 5% in taxes is much larger than the person making $90,000. So their focus is taxes, while the ordinary person a 2% or 6% increase or decrease in taxes doesn’t really have a huge bite. They are buying what they need and can afford on a limited budget while a very wealthy person is buying in the same manner, but more expensive items and paying more taxes on those items. So taxes themselves are a structure of percentage that alarms one based on their income and purchasing levels.

    The real financial engineers are in the financial sector or in the upper levels of the investing game such as CEO’s as they can influence stock prices. Speculators can drive up prices, but their also has to be a created demand and information that a given price is valid and worth while to sustain a price.

    Taxation was lowered basically across the board in the last administration. It would be nice if government spending could be lowered in the same fashion, but it’s not going to happen. Standard & Poor’s can see that would be the best way, along with raising some revenue. The two parties can’t see it that way.

    I would recommend your additional tax on stock sales. And instead of just a mild cents per transaction, I think a 1.5% of profit value would be more in line for investments held under five years. After five years, the transaction tax drops off. I don’t think buying in an IPO or the aftermarket should make a difference. Everyone wants to get rich fast and no one wants to become rich slow. I always point out how irregular the tax code is for the money one sweats to earn is taxed at a higher percentage than the money that is made in passive investments. But I think that oddity needs to stand and I would suggest lowering the capital gains tax to 12% for all investment income and 8% for gains held more than six years. But as most people can see, there is whole lot more wrong with the economy in general than just taxes and investing. We’re getting the efficient capitalist game wrong in almost every direction.

    Comment by Darryl Crouch -

  28. Mark – whether Mitt is more investor or businessman is actually meaningless to me. He likes to repeat, ad nauseum, that he is a businessman to dilute the idea that he has been as much a career politician as the President – he ran for office in the early 90s and has largely been running for office most of the time since then. And that is the problem I have with him – he has changed positions multiple times while pursuing office – not just on financial policies but on just about every major area. And while he claims to have been a Governor who worked across the aisle, he vetoed nearly 800 bills in a single term – nearly always overridden. I just do not see where Romney has really offered much beyond what President Clinton says he has -i.e., the Romney campaign really is all about: Have the last Republican administration leave a horrible mess, say Obama isn’t cleaning our mess up fast enough, so fire him and hire me because I am a “businessman”.

    As you wrote in 2008 but paraphrased to apply to this particular election I doubt you will make investment choices differently with Romney as President as opposed to the incumbent. And that is not because of “uncertainty” or “ObamaCare”. But if a Romney administration got us into war in the Middle East and spends another 2 trillion bucks on ‘defense’ I suspect you would rethink your investment options – in a negative way.

    Comment by Patrick Pine -

  29. Mr. Cuban thanks for a thought provoking article. IMHO you have some valid points and some not so much, but hey it’s your blog! Thanks again, really. By way of feedback and keeping your head in check with all the “run for president’ chatter, I’ll consider voting for you for president when you can actually catch your elbow on the rim playing basketball :)

    Comment by John Joseph -

  30. Mark – Enjoyed you blog today. Great explanation of what the Stock Market was originally created for and why mixing investments and money roulette (Financial Engineering) should be kept seperated and taxed differently.

    Currently reading your book and enjoying it!

    Thanks

    Comment by Mick Fields (@jffmick) -

  31. Reblogged this on analyticalsolution and commented:
    Nice article from Blog Maverick

    Comment by analyticalsolution -

  32. So what’s the verdict on Romney, investor or businessman?

    Comment by Andy AndLisa -

  33. Mark really enjoy your insights and your thinking. But as to the “Oh Shit We Missed It Fund” – do you see this covering “too big to fail” companies? And where exactly do you see these funds going and what would constitute dipping into this fund without abuse?

    Comment by Tony Pompei -

  34. Hey Mark,we here at Westco Services believes that the diff of Business need to be broaden.

    Comment by Timothy West (@West1Westco) -

  35. Mark,

    I’ve got to hand it to you, your blog is always refreshing and compelling. I’ve been trying to convey my concerns about Financial Engineering to people for years and I haven’t had exactly the right words to clearly explain what is wrong with the markets. I have explained to people that there is a difference between investment that grows businesses and produces jobs and mere profiteering, which bleeds the market of useful capital and creates cyclical market failures that would not occur otherwise.

    You have clearly pointed out the difference between leveraging for the sake of leveraging where unnecessary risks are taken for an additional basis point rather than making sound investment decisions. It is truly difficult to distinguish between smart risk-taking and the wanton risk-taking that is promoted by our current tax provisions and economic policies.

    Hopefully whomever resides in the Whitehouse come January is a reader of your blog!

    Comment by David Hamu -

  36. Your financial insights are always appreciated! All high schools should have a “Shark Tank” like class as a mandatory credit.

    Comment by marcblacks -

  37. Once again, Mark….you are right on target

    Comment by Tom Rubens -

  38. So, Mark, when are you going to run for president? :)

    Comment by Heidi Thorne (@heidithorne) -

  39. Hello my name is raphael rosembert , I admire all your work sir , at the same token I would to be teach by a mentor like you , I understand ” rich , wealthy ” is simply a mindset and habits, I would really want to absorb a lot from a great man like you. I have great ideas and need capital to start off please feel free to get back to me

    516 468 8011 .. Email : rrosembert@gmail.com
    Sent via BlackBerry from T-Mobile

    Comment by rrosembert@gmail.com -

  40. Another extremely insightful post. Now, how do we make this happen? Voting for another rubber-stamp politician won’t do it. We need a path forward to make this happen. I am willing to do whatever it takes to drive it because I have the same concerns, but where do we start?

    Comment by tomcgamble -

  41. Exactly Mr. Cuban, we cannot continue to do the same failed things over and over. At present we are headed in the right direction but cannot now afford to go back to the lack of regulation which caused the financial meltdown that Obama had inherited. I was a Republican for most of my life but now find myself to be a liberal without changing my positions. Understandably anyone who has massive wealth would put their well being above the nations. Sorry for going off topic and I enjoy your blogs. I am a 65 year old Vietnam veteran, college, logistics, retired.

    Comment by Steven Klasz -

  42. Some interesting discussion starters, for sure. I disagree with almost every proposed ‘remedy’, but still definitely an interesting topic.

    I think the arguments are weaker (than normal for Cuban) because the post starts out with the false premise that the 2008 crisis was similar to the 1987 crash.

    Cuban says “In 2008, funds trying to squeeze out another basis point or two thought they were being conservative buying insurance on heavily leveraged portfolios of sub prime loans and other debt.”

    In reality, it would read “In 2005-2007, funds had positioned themselves to profit massively from the gross mis-pricing of risk by buying insurance on heavily leveraged portfolios of sub prime loans and other debt. In 2008, market forces finally manifested themselves, and the folly of the mis-pricing of said risk was exposed. Those institutions should have been allowed to fail, but they were bailed out.”

    Comment by Pacioli -

  43. Cuban 2016.

    Comment by allcommercial -

  44. The market inefficiencies caused by risky or irresponsible behavior on the part of the people you label “financial engineers” does create additional short term risk and uncertainty in the market (and arguably exacerbates the boom-bust cycles and short-term price volatility) but that actually creates opportunity for value-oriented investors to profit. Your entire argument comes from the perspective that volatility and irrational behavior in the markets is a bad thing for “investors”; that could not be further from the truth. The more irrational other market participants are, the more opportunity there is for rational investors to profit at their expense. Let’s look at a few examples:

    1) Knight Capital’s HFT “disaster” yielded substantial benefits for many investors who traded against the faulty program.

    2) The JPM “London Whale” who caused JPM to lose ~$6B actually presented an incredible opportunity for hedge funds that were smart enough to take the opposite side of his trades.

    3) The 1987 crash presented great long-term opportunities to those who bought following the decline and held over the next 10-12 years.

    4) If the most irrational trades during the May 2011 flash crash were not reversed by the exchanges, I can assure you that anybody who bought Accenture at $0.01 a share would be smiling.

    As a value investor, I am grateful that other market participants do irrational and speculative things that have the potential to result in short term volatility and irrational company valuations. That creates OPPORTUNITY for rational investors to trade against them. There are two sides to a trade and the fact that somebody else is doing something stupid gives you an opportunity to do something smart!

    From MC> as an investor you are exactly right. When people make bad moves in the market it leaves the door open for me. Thats why I always have cash available. Big mistakes are big opportunities

    That said, it misses the point.

    As a CITIZEN of the USA its horrible for us. You create systemic risk. You kill jobs. You create deleveraging which in turn causes businesses to fail.

    Sometimes you have to be a Citizen first

    Comment by Lenny Grover (@lennygrover) -

  45. Hi Mark, I love this post and agree that more should be done to incentivize real investments and de-incentivize financial engineering. The former is good for our economy, the latter is a game that takes advantage of financial systems for individual gain. It’s too bad politicians won’t be pushing anything like this through in the near future. If you decide to run in 2016, you’ve got my vote! ;)

    Comment by Joseph Putnam (@JosephPutnam) -

  46. Thanks again for your insight and sharing experience. Do you have someone who translates your language to share with the rest of America? I share your posts frequently but don’t think they’re reaching those who I’d like and am in effect preaching to the choir.

    Comment by rkurhajetz -

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